As Lehman Brothers (LEH) turns into a single digit financial midget on its way to zero, as Washington Mutual (WM) works its way towards a buck, as Wachovia (WB) drops more than 80% over a year, as Fannie Mae (FNM) and Freddie Mac (FRE) become divisions of the United States of America, and are now priced in pennies — we need to reflect upon the ongoing lessons learned from all these interventions by Treasury, Congress and the Federal Reserve.

• Go Big: Don’t just risk your company, risk the entire world of Finance. Modest incompetence is insufficient — if you merely destroy your own company, you won’t get rescued. You have to threaten to bring down the entire global financial system. The fear and disruption caused by a Bear collapse is why it was saved. (AIG has the right idea on this)

• If you cant Go Big, Go First: Had Lehman collapsed before Bear, then the same fear and loathing of the impact to the system might have worked to their advantage. But having been through this once before, the sting is somewhat lessened — especially for a smaller, lets interconnected firm like LEH. (First mover advantage!)

• Threaten your counter-parties: Bear Stearns had about 9 trillion in its derivatives book, of which 40% was held by JPMorgan (JPM). Some people have argued that the Bear bailout was actually a preventative rescue of JPMorgan. Its a good strategy if your goal is a bailout — risk bringing down someone much bigger than yourself.

• Risk an important part of the economy: If your book of derivatives is limited to some obscure and irrelevant portion of the economy, you will not get saved. On the other hand, if Mortgages are important, credit cards and auto loans are too. Securitized widget inventory is not. To use a dirty word, Lehman’s exposure is "contained."

• Balance Sheets Matter: Focus on the media, complain about short sellers, obsess about PR. These are the hallmarks of a failing strategy — and a grand waste of time. Why? Its call insolvency. ALL THAT MATTERS IS THE FIRMS’ BALANCE SHEET. Lehman’s liabilities exceed its assets, and they are now toast. Merrill Lynch got a lot of the junk off of its books, and got a takeover at 70% premium to its closing price. And Credit Suisse, who dumped much of its bad paper many quarters ago, is in a better tactical position than most of its peers.

• Unintended Consequences lurk everywhere: When the Fed opened up the liquidity spigots via its alphabet soup of lending facilities, the fear was of the inflationary impacts. But the bigger issue should have been Complacency. The Dick Fulds of the world said after Bear, these new facilities "put the liquidity issue to rest." Lehman got complacent once liquidity was no longer an issue — perhaps they acted to slowly to resolve their insolvency issue in time.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

• Don’t just risk your company, risk the entire financial world. If you merely destroy your own company, you won’t get rescued. You have to threaten to bring down the entire global financial system.

Bank of America has bought several barges full of toxic waste over the last few months (years). It also controls something like 10% of all consumer deposit accounts. Is it now perhaps a systemic risk? Does anybody worry about this?

Are there any lessons for the financial media though? I mean, for months we’ve had to listen to these guys come on CNBC and basically unchallenged say everything is okay or at least, getting better.

I hope it is clear by now that a great deal of post-mod finance capitalism depended far more on public psychology than private capital or enterprise. Another reason why we are where we are today is that the financial media, especially on the TV side, are (were?) nothing more than the propaganda wings of The Street.

Just a couple of points that I believe can ensure that this type of situation can never happen again:

1. Change the law so you can not walk away from personal debt and the debt follows you for the rest of your life. That should stop the “jingle mail” phenomenon. This actually the norm in most countries.

2. Change the law so shareholders are liable for any debt held by the company they own shares in. That should change the attitude of mindless, clueless private and public shareholders.

Anyway I believe the above is a lot cheaper then the mess created by Paulson & Bernanke.

Please don’t, that’s my bank. I’m way under $100k but I don’t want to deal with it.

“Bank of America has bought several barges full of toxic waste over the last few months (years). It also controls something like 10% of all consumer deposit accounts. Is it now perhaps a systemic risk? Does anybody worry about this?”

I’m listening to Bloomberg radio while I work and the anchor just lambasted Bank of America’s CEO for using buzzwords in his press conference to describe the Merrill Lynch buy. It seems BofA is being very smug about it.

Lewis better be God, Buffet and Christmas combined. When I think of impact of everthing that he controls, I shudder. A foreign entity can now make a run at them, when they get in trouble, and we suddenly become a subsidiary of Dubai, etc. Scary times for sure and I’m sure that we have not comprehended the impact by half yet.

Why does CNBC put all of the Bears on last night and then brings all the “Not on duly pesstimistic,” types in the morning before the Open? They (CNBC) SHOULD BE HELD ACCOUNTABLE FOR THEIR SHCEDULING – think of all the investors that listen to there everyword (I know no one should listen but they do), and how it has supported a market equilibrium price that is totally abnormal. SHAME ON YOU CNBC!

But there was still a huge bailout — only indirect instead of direct. The Fed have said that the are now accepting a lot more types of paper to a lot higher limits than they were. This is code for “we are bailing out Lehman’s creditors”.

Also the big surprise is Merrill Lynch. If anybody thinks that they lost their independence because they were happy to cash in, they are very wrong. The 70% premium? Well, the current stock price is not exactly the most awesome:

I stopped watching ALL financial TV shows about 6 years ago – have been making much better investment decisions since. There is no information I need from TV financial journalism that I can’t get from the internet or selected print media. Just get away from the emotion.

I will say that I learned one thing from Jim Cramer that I have found extremely useful – “Ringing the Register”. Take profits on an investments when they have soared to unreasonable heights (also, in a short period of time). It may sound simple and obvious, but not that many actually do it. Cramer may deserve some ridicule in a couple of areas but this is one tactic that that has helped me tremendously and I give him full credit for it.

If what I am reading about the loss of confidence by the Chinese and others overseas is true, they are apparently going to get out of our markets and look for alternatives…if this happens, rates will go up. Just have to.

Paulson and Bernanke did not create this mess. Both are trying to clean up a mess created by others most notably Easy Al at the Fed and the lax regulatory and fiscal policies of Bush and co. BR ever considered instituting a Finance 101 test for your posters.

WaMu is a savings and loan that takes deposits which are FDIC insured. Unwinding it would be simplicity itself by comparison with LM. The machinery for taking it over already exists in the FDIC. A WaMu failure would cause scarcely a ripple.

Overal, perhaps the biggest lesson of this story is not that it pays to be both grossly insolvent and a system threat, or to lend to grossly insolvent systemic threats; the big story, the ultimate lesson is the one that you Barry made obvious nearly a year ago:

Hasn’t housing in modern times always been purchased on margin? 10% down and a 90% mortgage, a 10/1 leverage, was how I an millions of others purchased our first homes. Of course you had to produce mountains of back up to get it but it was and is the norm. Stock speculation on margin was at least as bad in the twenties. Uh..oh. While margin speculation maybe a factor in stock run ups you can’t lose sight of the fact that about 55% of daily volume on the NYSE and LSE is by hedge funds, private equity funds and the proprietary trading arms of banks. The ultimate insiders.

It strikes me that the financial industry thinks its implosion (finally coming, it seems) will destroy the real economy where things are actually made and consumed. We’ll see.

It used to be that a dollar of fiat currency represented something real. Since the mid 80′s or so, reality became inverted, and a good or service instead represented a dollar. But w/ 30-50 times leverage in the financial, real estate, etc., world, it increasingly became difficult to understand exactly what a dollar represented.

Perhaps this shake-out will return to dollars to representing value, instead of the other way around. And maybe we’ll realize that the real economy should drive finance, and not the other way around.

John(2):
Bernanke was on the Fed Board while Greenspan was the head honcho. Paulson was at Goldman Sachs before taking over the Treasury job. So they both take a small part of the blame. There are others that get a lot larger share of the blame.

John(2):
Bernanke was on the Fed Board while Greenspan was the head honcho. Paulson was at Goldman Sachs before taking over the Treasury job. So they both take a small part of the blame. There are others that get a lot larger share of the blame.

22 minutes…not. Erin Burnett said the Dow was only down 100 or so 3 minutes into trading. Justin mentioned earlier the cavalcade of asshats on CNBC and that is continuing unabated, the last one that Iowa State PhD with the scruffy beard. I have had the volume off for the last 20 minutes so the analysis my brain is perceiving in the background has improved substantially.

1. Opportunity to pay premium price for unknown liabilities
2. Great chance to acquire a management team known for spectacular failures
3. Need a dose of OTTI (other than temporarily impaired assets)
4. Looking for team of “creative” accountants
5. Add to complacent board of directors
6. Avoid low-cost, build from within strategy
7. Take on high priced real estate leases from last year’s market
8. Don’t want to watch hated competitor twist in the wind
9. Thought “wasting assets” had something to do with successful weight loss franchise
10. Didn’t have enough troubles of your own

@CNBC Sucks: You’re right but she did note that only half the Dow had opened. Once the other half opened, it went down to about 300 points.

Love Burnett’s the market’s receiving a “colonic” analogy and now is all clear for happy times again. Part of me almost WANTS the market to tank so these people lose their jobs – - because we know what ratings look like on CNBC when markets go really south.

The most worrying conclusion is that large Banks Ceo’s have proved to be unfit and or unable to manage their banks through risk diversification.
The ongoing banks consolidation is going to produce mutants of larger size and real weapon of mass destructions. None of the causes and abscond derivatives markets are under anybody’s control as the aim is to produce « primary markets » looking like their derivatives. Since the demise of the sub prime derivatives few clones have been born LCDX primer etc
In summary banks were large they will be larger, banks were difficult to manage they will be unmanageable , derivatives markets were larger than the primary markets they will survive the primary markets. No one is taking responsibility for this mess and no clear control seems to be born?

gotta luv Ken Lewis, just said he always thot commercials would end up owning investment banks “because of funding issues”, YES! Ken that’s right the world would be much better off if the traders and private equity guys at LEH and AIG and BSC had the NATION’S DEPOSITORS to rely on for their CRACKPOT schemes instead of just wily shareholders. what a joker

Could some of you veteran traders, please tell us what is a normal (percentage wise), sell-off during prior stresses such as this one that is occuring now? Something is not kosher, the reaction to the downside does not seem like it is nearly enough.

If what I am reading about the loss of confidence by the Chinese and others overseas is true, they are apparently going to get out of our markets and look for alternatives…if this happens, rates will go up.

The absolutely best thing that could happen for the U.S. is for the Chinese to cut us off. It’d be like Dunkin’ Dunuts finally closing the free donut shop next to the Diabetic Fat Farm. The treatment and healing could finally begin for real, before we have to amputate anymore limbs.

By virtue of the authority vested in me as President by the Constitution and laws of the United States of America, and in order to establish a Working Group on Financial Markets, it is hereby ordered as follows:

Section 1. Establishment. (a) There is hereby established a Working Group on Financial Markets (Working Group). The Working Group shall be composed of:
(1) the Secretary of the Treasury, or his designee;
(2) the Chairman of the Board of Governors of the Federal Reserve System, or his designee;
(3) the Chairman of the Securities and Exchange Commission, or his designee; and
(4) the Chairman of the Commodity Futures Trading Commission, or her designee.
(b) The Secretary of the Treasury, or his designee, shall be the Chairman of the Working Group.
Sec. 2. Purposes and Functions. (a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation’s financial markets and maintaining investor confidence, the Working Group shall identify and consider:
(1) the major issues raised by the numerous studies on the events in the financial markets surrounding October 19, 1987, and any of those recommendations that have the potential to achieve the goals noted above; and
(2) the actions, including governmental actions under existing laws and regulations (such as policy coordination and contingency planning), that are appropriate to carry out these recommendations.
(b) The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.
(c) The Working Group shall report to the President initially within 60 days (and periodically thereafter) on its progress and, if appropriate, its views on any recommended legislative changes.
Sec. 3. Administration. (a) The heads of Executive departments, agencies, and independent instrumentalities shall, to the extent permitted by law, provide the Working Group such information as it may require for the purpose of carrying out this Order.
(b) Members of the Working Group shall serve without additional compensation for their work on the Working Group.
(c) To the extent permitted by law and subject to the availability of funds therefore, the Department of the Treasury shall provide the Working Group with such administrative and support services as may be necessary for the performance of its functions.

Aye. Not a chance. The big players are just 5 steps ahead of the individual investor. If the markets were to behave rationally to you then the big players wouldn’t make enough money. That may feel like rigging, but I honestly believe it is just contrarian gamesmanship, within the rules, on a massive scale. Which is not the same thing. The big boys want to make money too, but if they use the same predictors you are, that won’t happen. If market manipulation were really going on, it would only take a week for the players to be utterly broke and out of the picture.

Mark E Hoffer, YOUR SHITTING ME! I can see the wisdom in putting curcuit breakers in, but to give an all-out OK, to do anything is lacking in so much judgement that I cannot begin to address it. Mr. Market will get his due!!!

You know the minupulation begins at the very level II screen that I am watching. What would trading actually be like in a perfect world with total and accurate transparency? Quite the thought experiment, no?

Bill Gates, Warren Buffett, if your listening take some of your extra cash and start a New Country somewhere, where only true transparency and efficent markets are practiced. Somekind of “test market” if you will. I’ll volunteer. Perhaps we could get a big grant from the governments around the world to help in the “study?”

So the answer is to make BofA even bigger and more unmanageable? What happens when Ken Lewis is gone and there’s no superhero available to pilot the Hindenburg?

I have yet to hear anyone question whether this deal must pass any regulatory scrutiny. Yes, Kudlow will have another hissy fit if that’s even posed, but just saving the market for one day is not reason to look the other way on a deal of this magnitude.

REPUBLICAN DEREGULATION AND FINANCIAL INSOLVENCY
In 2004, the US SEC deregulated the leverage rules for investment banks. What had been regulated at 10-15 to 1, was eliminated. The investment banks then levered up to 30-1 and perhaps higher. When the crises broke, it was compounded by the high leverage. For every dollar lost, 30 dollars of leverage fell.

Next within the last few years the stock exchange eliminated the uptick rule. Again damaging the system.

To further encourage speculation in the markets taxes were lowered on capital gains. Many of the hedge fund managers now pay virtually no income tax by claiming that their earnings are in the form of a capital gain.

Instead of money creating production jobs in the economy, the tax benefit to the rich went into creating dividends and cap gains as they invested in the stock markets. History proves that these tax incentives always produce the same effect. Witness the tax structure before the Great Depression.

Again, the unregulated derivatives’ market has helped create this mess. Instead of allowing Bear Sterns to file for bankruptcy it was bailed by the US taxpayer. All because it was too big to fail in part because of the counter party risk.

Also, the short sellers have run wild by trading naked shorts. Again, no regulation.

Hedge funds account for 40% of the market trades on any given day and yet they are not substantially regulated. Imagine the consequences of such action.

Profits of the few have overwhelmed the financial system created for the benefit of the many.

Next, the GAAP and FSAB have rules that encourage manipulation of assets on a company’s balance sheet. A typical problem is company assets that are marked to model. That is computer model, not marked to market. Debts and investments can be moved off the books of a company in SIV or SPE. No transparency and certainly adverse accounting. When a crisis occurs, this too rapidly unwinds.

A company with what had appeared to be a strong balance sheet finds that mark to model was, in fact, based on little more than fantasy when these assets are sold into the market to raise capital. Thus, their ratio of assets to liabilities rapidly diminishes causing potential insolvency.

As the unwinding of the credit bubble continues, and it will, it may look like a Cat-5 Hurricane. Basel II will not settle or calm the markets. Strong regulation is needed.

We are now looking at a Cat-5 financial crises based on the Republican deregulation and free market principles. Corporate America has substituted debt and leverage for real earnings, and looks into the face of insolvency. The majority of America workers now face insolvency as their wages have stagnated and their consumption was fueled with debt. Debt was substituted for income.

Thanks, guys. I had poked fun at the myth of institutionalized market manipulation (http://cnbcsucks.wordpress.com/2008/06/06/ok-enough-venting/), but I never actually thought it could be real. The question in that case would be: Whose capital – which must be at massive levels to control entire markets even at the lower volumes we have been seeing – is the Plunge Protection Team putting at risk? I suspect that would be the public’s.

I don’t know if this is market manipulation or a Westburied investor class that immediately finds solace in any excuse for optimism it can find, but the Dow has been in an incredibly tight trading range today, given the news yesterday plus AIG plus WM. Financials tanking couldn’t possibly be a rationale for buying something else for the entire investor pool, and I have a tough time accepting something natural like the theoretical free market could have achieved equilibrium so quickly.

@Darkness: You may be right, but that’s assuming our government isn’t helping to the prop up these markets. How do you know they aren’t doing that? How does anyone know for sure?

I, personally, know for sure, but YMMV. How about this, I wouldn’t put attempting to manipulate the markets past this administration. They are just dumb enough to try anything and suffer the classic overconfidence of those lacking knowledge of complex systems in everything they do. Their sphere of knowledge is always about marble sized so they get cocky and barrel on in without second thought. So, I’ll give you that point.

True, also, that the government as manipulator would not have the limitation of running out of money, or they certainly seem immune to that.

But the real clincher for me is that manipulation on that grand a scale makes the market predictable . . . in ways that anyone can milk for unlimited profit. You, me, hedge funds, anyone. As soon as that happens the system breaks down completely. That hasn’t happened, therefore, in my mind, the manipulation isn’t happening.

GE Capital!!! I finally get it…no wonder the CNBC gang keeps on pumping – in a rather stealthy manner I might add. After all I am sure that they are privy to some of the best marketing brains in the business. SHAME ON YOU CNBC!!!

Interesting morning. I am not trading today although I might do something small later, there are just way too many bazookas out there for me to put much risk on.

Looking at the action so far – an absolutely huge yield curve steepening, SPX 1215 and XLF 20 holding, NAZ only down ~20, then I would guess:

1) Mr Market smells a rate cut tomorrow
2) If it doesn’t happen, we get a big-time sell-off
3) Nobody cares about LEH except employees
4) AIG is not yet at death’s door… yet.
5) The journey from denial to fear is not yet complete
6) Steve Barry must be very frustrated today
7) The XLF trading range (20-22) is intact and profitable
8) The market is resilient (CNBS) or the PPT is busy

Mark E Hoffer: yes, i think we see $75 oil, but first we see reflation attempts so i would be long oil stocks – for a trade.

VT Trader: next group in the woodshed, stocks exposed to cap ex – that would be tech, right? which leads to:

Stevo: sure you’re right on QID, massive over-valuations there. BTW, great calls for the last two weeks.

What I don’t understand is that with so much happening out there, why doesn’t the US market crash. It just takes everything in its stride. What is it that is way way wrong out there? Why can’t it just crash? WHO BUYS everytime?
Or is it that billions and billions of losses and a few banks vanishing just like that mean absolutely nothing?
This is so goddamn frustrating.

“Buffett in talks with AIG.” How many times is/has Buffett been used as a rumor on the up-side? Oh, he might even come out and give an interview, but that doesn’t mean that it will be ligit. Going long is so much easier than going short. No wonder things are so distorted.

Hank Paulson has sold this country out to the Chinese.
He gives JP Morgan a backdoor bailout with the Bear Stearns deal. It just so happens that the Chinese own a large part of JPM. He bails out the Chinese bond holders of Fannie and Freddie. He allows the Chinese to manipulate their currency for unfair advantage, something they have been doing a lot of lately.

Country First? The first country in Hanks mind is China. If countries like China and I-banks like JPM are going to squawk about the joys of the free market to everyone else, then its time they experienced the FULL joy, and not expect US taxpayers to backstop the investments they made that have gone bad. It is not too late to change the Bear and Fannie/Freddie deals.

Reputation and trust are the cornerstones of financial stability. Once public confidence is eroded, an institution loses the ability to fund illiquid long term assets as credit availability evaporates.

Reports say AIG could not reach a deal with KKR and JC Flowers to procure capital; so it’s asking the Fed for a $40B bridge loan.

The gall of AIG! In one of the worst financial crisis in US history AIG rejects a private-sector solution because AIG believes it can procure a better deal via taxpayerbacked largesse/crony capitalism. This is why Hank & Ben had to allow Lehman to fail.

it seems that all newspapers today praise the fact that paulson didnt spend any taxpayer money on lehman. now:
1. wasnt lehman borrowing at the fed’s primary dealers credit facility?
2. how much?
3. what collateral did they pledge?
4. will the fed need to stick to it? will they recover all the money they lent to lehman?
5. is the taxpayer better off now?

i am too lazy to answer those questions myself. the answers may be interesting. maybe not.

What I find really disturbing is that Phil Gramm, who spearheaded the removal of banking regulations (It’s in your mind and whinners guy), is in line to be Secratary Of Treasurer if McCain is elected (Paulson already said he will not stay on). History will show Greenspan and Gramm along with inefficent goverment enforcement of controls led to the financial crisis which will get worse before it gets better. Gramm scares me more than McCain or Obama in the damage that may result.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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